Who Gets Paid First (and Second, Third, etc.) in Bankruptcy

What is the Hierarchy of Claims Under the Absolute Priority Rule?

If you are a vendor, service provider, or another unsecured creditor to a chapter 11 debtor, you cannot be blamed for feeling like a duped lover after learning about the bankruptcy of your once devoted business companion. Despite the promises of “I’ll stand by you if you stand by me,” all those outstanding invoices won’t be paid after all. If it helps soothe the pain (and of course, it won’t), it’s not just you. The landlord, the copier company, the messenger service, and even the weekly “Power Lunch Yoga” instructor fell for the same story. You’re in the same chain of fools. Only now, you contend with one another over the tiny bankruptcy dollars to be shared, pro rata, among all of the debtor’s unsecured creditors.

If not you, who gets paid first according to the absolute priority rule, or order of priority?

Why the Proof of Claim Form Won’t Entitle You to Priority

As the sting of the break-up starts to finally wear off, you will receive a “proof of claim” form and instructions from the bankruptcy court. You note that Section 5 of the official form has a blank line for “Amount entitled to priority.” Your first instinct may be: “That must be me!” After all, how many times did the debtor tell you that your invoices are “priority number one” just as soon as you help the debtor through its rough patch? Surely your claim must take priority over the lame claims of the yoga instructor, right? But before you fill in that tiny blank with “All of it!!!” make sure to read the small print. You’ll see that Section 5 permits you to file a claim for priority only if your claim is “entitled to priority under 11 U.S.C. § 507(a).”

Section 507(a)

Section 507(a) of the Bankruptcy Code describes the types of unsecured claims entitled to priority status and reflects the bankruptcy policy of favoring certain types of creditors over others, even among creditors that hold no security for their claims.

Section 507(a) is part of an overall scheme of priority promoted by the Bankruptcy Code that is critical to the function of the bankruptcy process. For example, with respect to chapter 11 plans of reorganization, the rule of “absolute priority” bars any class of creditors or interest holders from receiving any distribution on account of their claims unless all claims of each senior class are paid in full. Thus, all secured creditors must be paid in full before unsecured creditors may be paid anything; and all unsecured creditors must be paid in full before holders of equity receive anything.

Section 507(a) provides further refinements of priority even among unsecured creditors, elevating the claims of certain unsecured creditors to “priority” status over the claims of “general” unsecured creditors. In a chapter 11 case, a plan of reorganization or liquidation cannot be confirmed unless the claims entitled to priority under Section 507(a) are satisfied in full in accordance with Section 1129(a)(9) of the Bankruptcy Code. Claims of general unsecured creditors – aka, the chain of fools – will share, pro rata, in whatever money is left over.

So what does this bankruptcy absolute priority policy mean for your claim? Can you check the box in Section 5 of the proof of claim form and elevate your unsecured claim to priority status, allowing it to be paid ahead of the rest of the debtor’s spurned creditors? You can, of course, though your claim to priority probably will fall upon objection.

The Rank of Priority Claims

Section 507(a) lists and ranks ten categories of priority claims. The listing and ranking reflect Congressional policy judgments and, perhaps, the effects of lobbying (for the more obscure ones). The types of priority claims, as ranked in Section 507(a), are as follows:

1. Certain claims resulting from domestic and child support obligations (These types of claims are given priority for obvious reasons but are not relevant in most chapter 11 cases.)
2. Costs incurred during the administration of the bankruptcy case (These include the fees and costs of professionals retained in the bankruptcy case.)
3. Costs incurred before the entry of the “order for relief” in an involuntary bankruptcy case
4. Claims of employees, subject to a cap, for salary, commissions and other benefits earned within the 180 days immediately preceding the bankruptcy
5. Claims for contributions to an employee benefit plan, subject to a cap, incurred within the 180 days immediately preceding the bankruptcy
6. Certain claims of grain farmers and fisherman against storage and processing facilities
7. Certain claims of individuals related to deposits in connection with leases or purchases for personal, family or household use
8. Certain unsecured tax claims
9. Certain claims related to commitments for capital maintenance owed to a federal depository institutions regulatory agency
10. Claims for death or personal injury resulting from the operation of a motor vehicle or vessel while the debtor was intoxicated

General Unsecured Creditors, No Priority for You

Deflated, you have found that none of these priority categories applies to your claim. Notwithstanding fervent promises of loyalty and affection by the debtor, the Bankruptcy Code finds most creditors’ claims to be “general” unsecured claims only. Your claim is a mere general, unsecured claim, as are the claims of the yoga instructor, the copier company, the bike messenger, etc. No priority of payment for you. As a general unsecured creditor, you are left to await fractional payment, with that to come at some uncertain point in the future.

If the order of priority is a little too depressing, and you’re still feeling blue over the break-up, you may want to consider a support group, the “Official Committee of Unsecured Creditor” (but that’s a topic for another day).¹

We think you’ll also like:

1. Steps a Supplier Can Take in the Face of a Potentially Bankrupt Retailer
2. The Order of Claims in Bankruptcy: Absolute Priority Rule, Structured Dismissals, and More
3. 90 Second Lesson: What is the Difference Between Recharacterization and Equitable Subordination?

[Editors’ Note: To learn more about this and related topics, you may want to attend the following on-demand webinars (which you can watch at your leisure, and each includes a comprehensive customer PowerPoint about the topic):

1. The Nuts & Bolts of a Chapter 11 Plan
2. Help, My Business is In Trouble!
3. The Intersection of Bankruptcy and…Tax Law

This is an updated version of an article originally published on August 22, 2017 and was previously updated on November 7, 2018 and May 6, 2021]

©2023. DailyDAC^TM, LLC d/b/a/ Financial Poise^TM. This article is subject to the disclaimers found here.

1. Fortunately, we have a time machine to that day. Read Trade Tip #7: What is a “Committee”?